Question

A manufacturing company has some existing semiautomatic production equipment that it is considering replacing. This equipment has a present MV of $55,000 and a BV of $27,000. It has five more years of depreciation available under MACRS​ (ADS) of $6,000 per year for four years and $3,000 in year five. (The original recovery period was nine​ years.) The estimated MV of the equipment five years from now is $19,000. The total annual operating and maintenance expenses are averaging $27,000 per year.

New automated replacement equipment would then be leased. Estimated annual operating expenses for the new equipment are $12,000 per year. The annual leasing costs would be $24,300. The MARR​ (after taxes) is 5​%per​ year,t equals=50​%, and the analysis period is five years.​(Remember​:The owner claims​ depreciation, and the leasing cost is an operating​ expense.) Based on an​ after-tax analysis, should the new equipment be​ leased? Base your answer on the IRR of the incremental cash flow.

a. The actual IRR of the incremental cash flow is ?

b. The challenger should be leased or rejected?

​

Answer 1

Year	Sale of machine after tax	Tax benefit on Depreciation foregone	Sale of machine foregone	Saving in annual operating and maintenance post tax	Leasing costs after tax	Incremental cash flows
0	41000					41000
1		-3000		7500	-12150	-7650
2		-3000		7500	-12150	-7650
3		-3000		7500	-12150	-7650
4		-3000		7500	-12150	-7650
5		-1500	-9500	7500	-12150	-15650
					IRR	3.71%

Based on IRR, the lease should not be accepted since IRR is lesser than MARR

Formulae attached for reference